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Challenges Associated with the Expansion of Deposit Insurance Coverage during Fall 2008

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  • Schich, Sebastian T.
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    Abstract

    Government provision of a financial safety net for financial institutions has been a key element of the policy response to the current crisis, with governments extending existing guarantees and introducing new ones. These measures have been helpful in avoiding a further accelerated loss of confidence. But they are not costless. Like any guarantee, deposit insurance gives rise to moral hazard, especially if the coverage is unlimited. Clearly, in the midst of a crisis, one should not be overly concerned with moral hazard, as the immediate task is to restore confidence, and guarantees can be helpful in that respect. Nonetheless, to keep market discipline operational, it is important to specify when the extra insurance will end, and this timeline needs to be credible. To be able to establish such a timeline the root causes of the lack of confidence – that is the effects of troubled assets on financial firms' health – need to be addressed effectively. On a more fundamental level, once a government has ventured down the road of guarantee expansion, there may be a general perception that a government guarantee will always be available during crisis situations. As a consequence, other elements of the financial safety net may need to be strengthened, including the prudential and supervisory framework. --

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    Bibliographic Info

    Paper provided by Kiel Institute for the World Economy in its series Economics Discussion Papers with number 2009-16.

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    Date of creation: 2009
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    Handle: RePEc:zbw:ifwedp:7540

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    Keywords: Policy responses to financial crisis; safety net; deposit insurance; moral hazard;

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    1. Asli Demirguc-Kunt & Enrica Detragiache, 2000. "Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1751, Econometric Society.
    2. Laeven, Luc & Valencia, Fabián, 2012. "The use of blanket guarantees in banking crises," Journal of International Money and Finance, Elsevier, Elsevier, vol. 31(5), pages 1220-1248.
    3. Claudio Borio, 2007. "Change and Constancy in the Financial System: Implications for Financial Distress and Policy," RBA Annual Conference Volume, Reserve Bank of Australia, in: Christopher Kent & Jeremy Lawson (ed.), The Structure and Resilience of the Financial System Reserve Bank of Australia.
    4. Stephen Lumpkin, 2008. "Resolutions of weak institutions: Lessons learned from previous crises," OECD Journal: Financial Market Trends, OECD Publishing, vol. 2008(2), pages 1-42.
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    Cited by:
    1. Beat Bernet & Susanna Walter, 2009. "Design, Structure and Implementation of a Modern Deposit Insurance Scheme," SUERF Studies, SUERF - The European Money and Finance Forum, SUERF - The European Money and Finance Forum, number 2009/5 edited by Morten Balling, July.

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